Using real estate to maximize cash flow is a calculated, well thought out process that can be made easy by following evaluation steps!
Rental properties can generate both positive and negative cash flow depending on a variety of factors. To calculate the cash flow from a rental property, you must first understand your expenses, income, taxes, and other fees associated with owning the real estate.
When calculating the property cash flow, it is important to consider all potential sources of income. This includes any rent payments that you receive from your tenants as well as additional income such as late fees or pet deposits. Additionally, if there are any additional services that you offer to tenants such as cleaning or maintenance services, they should be factored into your calculations.
Once all of your income has been calculated it is time to examine your expenses. These will include any costs associated with maintaining the property such as mortgage payments, insurance premiums, utility bills, and taxes. Additionally, you will want to factor in any additional costs such as repairs or upgrades that may be needed periodically. Don’t forget to include any legal fees that may be involved in managing the rental property as well.
Finally, once your expenses have been calculated it is time to calculate your positive or negative cash flow from the rental property. To do this simply subtract all of your expenses from your income. If the result is a negative number then you are generating a negative cash flow while if it is a positive number then you are generating a positive flow of cash from owning the real estate.
Exactly what is cash flow real estate investing?
Cash flow when using a property is one of the most significant ways to grow your income in an extremely passive manner in some cases. Something else to understand is there is such a thing called negative cash flow. When considering cash flow when it comes to owning a property there are some times where the cash flow can be positive one year and negative on the property the next. So digging into what this means is important when trying to decide if the property is going to positively or negatively affect your overall position financially. This doesn’t just mean for your current situation but also for future home purchases where your credit will be evaluated by a lender team.
Understanding on many layers what you are doing when you initially buy a property, and also what you can do with the property after you have lived in it if buying as a primary home is very important. As we go through the process typically buyers and borrowers are looking at these from two different lenses. The first lens is the initial purchase. Is this a good property to buy that meets my expectations and standard of living right now? Can I afford it? Other questions that come with quality of life will typically be used when evaluating the property worth to a buyer. Some will go as far to do a market analysis as to what the property can bring after but most are just looking at the right here right now. Investors or buyers who think there may be a chance they are going to keep the property should also be shopping now for potential growth later.
That gets us into the next scenario which is the lens of a buyer looking at the purchases as an investment property right out of the gate. How can this property gain me a positive cash flow, and if it doesn’t should I move on?
Wouldn’t it be amazing if you could take a primary home and live in it, then keep it and offer it to a renter so they can enjoy all of the benefits and you have known the whole time that the property will most likely cash flow in a positive manner for you? Let’s dig in and marry the concepts of evaluating properties as not only a primary homes but also as an investments for your future up front, reducing stress later!
Why do you want positive cash flow?
Positive cash flow also referred to as effective cash flow is incredibly important when considering purchasing and taking out a loan for a property. Positive cash flow can be considered money off the top once your bills and maintenance are paid for.
Now that sounds very simple but you must also think about how to get to that and there are many layers of evaluation that need to be done to make sure that you are not getting in over your head. I want to acknowledge that in this blog we are going to get into some of the details but I also am going to give you the basic overview and acknowledge that I will leave out some details as they will drive other questions that are case by case.
What we are going over today is to help you understand the quick overview of a property and get you thinking about the factors that will have the most impact on positive and negative cash flow.
Factors that hurt your real estate cash flow
Excited to make money? This excitement can sometimes stop home owners from looking at the potential pitfalls of holding onto a property and trying to rent it out. It is of the utmost importance to review all information subjectively when thinking about becoming a real estate investor. Here are potential factors that can cause a gap in cash flow or hinder it from ever becoming a positive cash flow potential for you as an owner.
Tenant turnover
Tenant turnover is hard and can cause a huge gap in payment if you are not ready for it. So the basic concept is a tenant turnover is a period of time that all landlords should be prepared for.
Ask your property management team what their minimum standard is for a turnover period, get it in writing! This will help you ensure that your vacant time period has certain expectations on it.
When calculating your turnover time remember that you will need to cover the payment that you need to make to your lender, any taxes due and if the management company makes you pay them for the time the house is not collecting.
Also, something to consider is a tenants placement fee. This is typically one month’s rent but again something you most definitely want in writing where the management team lets you know exactly what is covered when they are trying to find a new tenant for your property and how much it will cost you.
Missed rent
When a tenant misses rent you are still responsible for ensuring you keep your own credit protected and that you make the payment. Multiple missed monthly payments and eviction costs can put you behind and get you into a negative cash flow situation.
Good communication with all parties involved is essential in these situations. Know your lease, know when to start an eviction process and remember this is a business. This means that as soon as rent is late, send over the fees, when the fees are not collected, follow your lease to the letter.
When these types of stipulations are happening also understand that all communication should be covered in writing and depending on your state laws should encompass an email summary vs text or he said she said. This will be very helpful if you have to defend your position.
Vacancy
Vacancy is when your property is unoccupied. The key to vacancy affecting your overall cash flow is to keep it short. Every day that there is not someone paying rent in your property you are not collecting rent and therefore hurting your bottom line.
Once again being prepared to cover the costs of periods of vacancy is extremely important to consider. One other thing that is critical with vacancy is be prepared to do maintenance at this time. Sometimes you will know of fixes that need to be made and this is a great time to get those knocked out to help you continue to keep your property in great shape and it is one less person you have to communicate with to set up times.
Your property management team should maximize these times and work for you to help you ensure the upkeep of your property.
Property taxes and insurance
Property taxes and insurance should be kept on different line items when one is trying to understand their full obligation to a payment. When a borrower is paying the lender with monthly payments through an escrow account these two fees will be adjusted based on the insurance bills being paid to the county assessor’s office and the insurance plan the owner provides annually.
Understand that although your principal and interest payments will not change the overall monthly payments can fluctuate as the property taxes and insurance policies will change every year.
Factors that help your real estate cash flow
Considering both ways to help your property create a cash flow and understanding potential risks you are taking on is extremely important to you as a real estate investor. Looking at potential ways to cash flow you want to consider the below:
Long-term tenants
Long-term tenants can assist with the overall upkeep of your property. This is one of the most steady, predictable ways to be able to calculate your annual income. Rentals in certain communities will rent from 1 year term to 20 year terms. It is very important to understand that with your rental you want to be able to account for how much it costs to get things fixed, increased property management costs, your ability to evict in different situations to protect your investments.
With long term rental tenants remember that you still want to do 1-2 year leases because you want to ensure that if things do not work out you have an ability to get them out of your house. The other item to consider is rental increases. If you sign a one year lease you can offer the option to increase the rent at the annual markers and this can help you cover the overall maintenance cost for the property as expenses for repairs and materials is going to increase over the years.
A long term tenant that pays on time for years is extremely beneficial and a great example of cash flows if the rental properties are finding a way to have the rent cover overall expenses. Understanding your market and the relationship with your property manager is a good starting point.
Preventative maintenance and repairs
Preventative maintenance and repairs are done prior to a larger issue coming about. So let me give you an example of one of my properties where the preventative maintenance wasn’t done and it cost!
Heaters are pushed to the max more than they ever have been with some of the frigid weather we have been experiencing. One property had younger tenants in it and we have filters delivered to the property quarterly and it is (well was) a set and forget situation. We set them to be delivered and we assumed the tenants were swapping them out.
In the dead of winter a work ticket is put in for decreased heat in the property. An HVAC tech was sent out to take care of the issue and this is when it was discovered that the tenants were unaware that the filter needed to be changed. They let the technician know that they were attempting to save us money so they were storing what they thought were filters that could be changed once a year in a closet!
The filter was swapped out but we did have to pay the service fee and a weekend emergency fee. So the point of the story, make sure that preventative maintenance is carried out so you are not $300 into the hole with an HVAC visit.
I use that example because it is an easy one and it is one that needs follow-through. Many management companies will also show you what they require you to pay and the price for carrying out preventive maintenance. This is an inquiry when you are shopping for a property management company.
Also, if you are going to self manage simply look up some free preventative maintenance lists on the internet, this can be very helpful.
Appealing property taxes
Appealing your property taxes can either be done by you alone with your local commissioners office or you can use the assistance of advisors in your local area. The benefits of appealing your property taxes is it can save you overall cash going out, remember property taxes unlike principal and interest fluctuate.
Property taxes are typically paid once a year, some cases split into two payments. If you appeal the taxes and keep them lower you will be required to pay less.
If your property is financed you usually can find the amount that is collected monthly in your escrow payment. If you have a paid off property you will be making lump sum payments in most cases directly to your local tax office.
Refinancing
Refinancing can sometimes change the structure of your loan. Talk to your financial advisor, or agent to better understand all of the ins and outs of what this will cost you. Sometimes, the fees that are put on the loan may not be worth it for you.
One situation to get you thinking about paying for refinancing is considering that if you refinance the loan, get a better rate or cash out you may be staging yourself to acquire more properties and this can be very important and worth the cost to some.
So how does this work? Let’s do it with an example for someone who may be trying to reduce their risk with one property and acquire another rental property.
You buy a home at $265,000 at 5% interest rate.
- 265,000 at 5% interest rate = estimated escrow payment $2000.00
You pay off a portion of the principal and then refinance decreases the interest rate.
- 245,000 at 4.5% interest rate = estimated escrow payment $1800.00
As you make payments and you decrease the loan amount you can refinance and make another $200.00 of cash flow in this situation.
Now, this is not for everyone and there are ways to decrease the paid interest overall, as you do not have to refinance it all the way back out to the 30 years. Just be mindful of what your goals are. In this case showing that you are making extra money off of your property you can make yourself and your portfolio more attractive to lenders.
As your portfolio increases you can also decrease your risk by decreasing your own payments towards the loans.
The 1% rule
The 1% rule is one of the most popular real estate investment strategies that many experienced real estate investors swear by. The rule states that the monthly rental income from a property should be equal to or greater than 1% of its net purchase price. For example, if you were looking at a net $200,000 real estate, the rent should be at least $2,000 per month in order to make it worth investing in.
This way of thinking has been around for quite some time and is considered by many real estate investors as an important factor when it comes to making sound financial decisions. By following the 1% rule you can ensure that your rental property will generate enough rental income to cover all expenses associated with owning the property such as taxes, insurance, and the mortgage payments. This cash flow can then be used to pay off the mortgage or reinvested into additional real estate investments.
In conclusion, the 1% rule is a reliable method for ensuring that you are making an informed decision when it comes to investing in rental real estate properties and can help ensure long-term success as a real estate investor.
How to create positive cash flow for your real estate
As you jump into the real estate investment process or you continue to work through the changing market, remember that going through all fees and costs is a very important piece of the puzzle.
There are many templates available to truly calculate the potential of a property you have or are going to acquire. You can also try to find an online calculator to help you with calculations and fine tune your business strategies.
The ADPI team is always currently creating content to better support those who have properties that they want to turn into real estate investor’s cash flowing properties! Look into the tools and sit down and decide if you are ready to make money in the long term or short term with the tools you acquire!
ADPI ProTips
- When one is to step into the investor world to increase cash from real estate investing you need to ensure you read all you can about real estate, rental income, real estate investing, and the financial gain that can come in the form of on time cash and or a revolving cash flow.
- When you compare commercial real estate and the single family markets you will typically have some sort of calculator to help guide you into what the rental income will look like. Many agents will help you understand what the rental income will look like when you are leaning into the purchase of operating a real estate business. As the investor you will generate cash but you must get familiar with the markets and understand what risks come with the mortgage you will take on.
- Having tools can change the access you have to great investment properties. Again understanding the markets that you are looking at an investment in will be essential for your real estate cash journey, Make sure you are always operating inside of your debt to income ratio to lessen the overall impact on your own quality of life. Now that you understand the ins and outs of the investment journey and producing rental income, get out there and find that deal! Happy property hunting!
